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Judge Shelley C. Chapman, of the U.S. Bankruptcy Court for the Southern District of New York, has ordered HSBC and Litton Loan Servicing (a Goldman Sachs subsidiary) to send officers with some juice -- and not low-level types -- to her Manhattan courtroom on Feb. 10 to explain themselves. More specifically, to explain their failure to provide adequate documentation about a mortgage they claim to own and service. Judge Chapman also ordered the Texas attorney who signed the documents to show up.

At issue is the fact that HSBC (HBC) hasn't come close to proving it owns the loan, and the documents it has submitted look funny. It also doesn't appear to have been acting in good faith when it comes to trying to modify the loan (also known as "loss mitigation"). So, the judge wants to talk to people who actually know things and can make decisions.

How Did HSBC Get the Note?

Here's the story:

In 2004, Miguelito and Jacqueline Garcia bought a property in New York City's borough of the Bronx, using a mortgage from Fremont Investment & Loan. Shortly afterward, that mortgage was apparently securitized, and HSBC became the trustee for securitized trust. HSBC hired Goldman Sachs's (GS) Litton Loan Servicing to service the trust loans.

Last summer, the Garcias declared bankruptcy, and Litton Loans told the court the Garcias owed HSBC some $3,600 in missed principal, interest and fees. (This isn't a foreclosure case, at least not yet.) To back up its claim, Litton gave the court the note -- stamped "Duplicate Original" (starting on page 3 of the linked document) -- and the accompanying mortgage (starting on page 10).

But the Garcias' lawyer, consumer bankruptcy attorney David Shaev, pointed out in a letter to Litton that the note was made out to Fremont Investment & Loan, and the mortgage was made out to MERS -- the Mortgage Electronic Registration Systems -- as nominee for Fremont. Litton didn't give the court any evidence that either document was transferred to the trust HSBC represented. In the first place, Fremont hadn't endorsed the note to anyone, and second, HSBC hadn't submitted an assignment of the mortgage to anyone.

Two Different Notes

Shaev didn't get a meaningful reply from Litton, so he formally objected to HSBC's claim. When Litton replied, it submitted a new note that was endorsed. But Litton's filing didn't address the fact that the first note it submitted wasn't endorsed, while it now it offered one that was. Nor did Litton mention several other oddities, such as the initialing by the borrowers on the new note is in a different order and position on each of the first two pages. Even the signatures on page 3 of the note look different -- for example, look at the "J," "a" and "q" in Jacqueline.

I'm not a handwriting expert, so I make no claim that someone forged the names and initials. Maybe Fremont had the Garcias initial multiple copies of the note when the deal was done, and they didn't initial each identically. Perhaps the Garcias signed two copies of the note at closing. The signatures on the two notes aren't wildly different from each other. The bottom line, however, is the notes aren't photocopies of each other.

So, unless the Garcias took out two identical mortgages, having two signed notes is a problem. Each is separate and complete proof of a debt.

For a moment, let's forget that the securitized trust exists and just imagine that Fremont endorsed one note to HSBC and one to, say, Wells Fargo (or any other bank). If either wanted to foreclose, each HSBC and Wells would have employees sign for MERS and assign it the mortgage. The Garcias would face two apparently legitimate foreclosure actions. That possibility is why the signature page of the note itself says "Sign Original Only."

Bad Endorsement

So one problem with the documents is that two "original" notes appear to exist. Another problem is that only one of these originals is endorsed to HSBC. And a third problem is that the endorsement, such as it is, doesn't make sense.

In seeming violation of the securitization contracts, the endorsement went straight from Fremont Investment & Loan to HSBC. That's a problem because in a securitization deal, the notes go from the loan originator (or a later owner) to the "depositor" to the trust. -- and the depositor is always in the loop. Since Fremont Mortgage Securities Corp. was the depositor in this case, the note should have been endorsed to it, and then to HSBC.

Beyond the two-note-and-endorsement problem, the assignment of mortgage is another question. Despite the fact that HSBC's right to the mortgage debt has been an issue for months, it still hasn't submitted an assignment of mortgage. And, as a credibility side note, Litton's attorney stressed in the opening paragraph of the firm's reply that he is relying solely on the documents provided by Litton, regarding the truth of the claims Litton is making.

That statement means the attorney couldn't try to foreclose on the mortgage right now if Litton asked him to. New York requires attorneys in foreclosure actions to actually talk to someone at the bank and affirmatively try to make sure the documents are accurate. The problematic documents in this case are a good indicator of the wisdom of that rule.

Not a Vintage Year?

One final cheery note: This mortgage and trust is from 2004, not the peak bubble years of 2006 and 2007. I want to believe the document mess in this case isn't typical of that year's vintage and that the document chaos was a bubble-frenzy phenomenon. But to be honest, I think that's as likely as the wishes I make on shooting stars ever coming true.

So, how far back in time need one go to find a securitization deal done carefully, such that its documents are in order and available to the trust's attorneys? How many mortgages is that?

Judge Chapman says she'll cancel the Feb. 10 hearing if the parties come to agreement in "loss mitigation," meaning they've agreed on a mortgage modification. An agreement would take a real change in attitude on HSBC's part, however. The bank's most recent offer, according to Shaev, involved a balloon payment at the end that wasn't defined. When he asked how much it was, he was told it would be however much the Garcias hadn't yet paid. That is, it would be a number HSBC could fill in later, after everything was signed. That's not a serious modification offer.

If the hearing does happen, I hope the judge finds out just how both original notes came to be -- why HSBC submitted one and then, without acknowledging the change, it submitted the other.

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What you will find, to the dismay of the entire financial system, is that this kind of fraudulent activity on the part of mortgage lenders, banks, and MERS since the date MERS was incorporated. Taking advantage of a lack of attention on the part of presidents, Congresses, regulators, financial advisers, attorneys, real estate brokers, and various and assorted elected officials at the state and county levels, the securitization of mortgages was allowed to proceed apace until the whole house of cards came crashing down in 2008. Unless federal, state and local governments get truly serious about investigating the wholesale ignoring of laws regarding the process of securitizing mortgages and hold those responsible legally accountable the process will continue as it has for the past however many decades. Because the whole system is fraudulent one judge, one court, one mortgage at a time will not cure the problem. It will require calling a halt to the securitization of mortgages until every mortgage involved in that process over the past thirty years has been reviewed and made legal. Because what will ultimately be proved is that with the advent of MERS any semblance of legality in this process was completely lost.

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Thank you for pointing out the busted link; the correct one is place now. The new note starts at page 2. It is very common for duplicates of all kinds of documents to be executed, but not notes for the reason I explain above.

As to the endorsement, it is true, if the endorsement is authentic, that it would give the trust the power to foreclose as a matter of the UCC. However the UCC allows parties to contract around its provisions, and it's hard to see how the securitization contracts and the law the trust was created under aren't express contracts around UCC's provisions.

No one is disputing that the debtors took out a mortgage with Fremont Investment & Loan. The issue debtors counsel has raised is whether HBSC/Litton is the right bank to put in a claim on that loan in the bankruptcy.

The defendant, Janet Alvarado, did not dispute that she took out a $292,000 mortgage loan from Washington Mutual Bank on a Bogota property. The mortgage was pooled, securitized and transferred to LaSalle Bank, N.A. which was acquired by Bank of America in 2007. When Alvarado defaulted in 2008, BofA went to court to foreclose as successor to LaSalle and WaMu.

Alvarado challenged the action on the ground BofA had not shown it had possession of mortgage note. The "produce the note" defense has become popular in foreclosure cases where banks that acquired large blocks of mortgages at once sometimes cannot come up with the paperwork showing that they actually own a particular debt on which they are trying to collect.

BofA admitted for the first time that it did not have the note on Aug. 20, during oral argument on its motion for summary judgment. It told the court that WaMu lost the note before it transferred the obligation and proffered an affidavit of lost note, dated July 14, 2006.

Thurber adjourned the motion to allow discovery but nothing was unearthed to alter the picture that WaMu lost the Alvarado note and prepared an affidavit to that effect when her loan was pooled and securitized. When the motion was reargued in December, both sides agreed that the "pivotal issue" was "whether the right to enforce a lost note or instrument can be transferred or assigned or, put differently, whether any person other than the person who lost the Note can enforce a lost Note."

The answer turned on N.J.S.A. 12A:3-309, which allows enforcement of an instrument by someone not in possession if that person was in possession and entitled to enforce it when they lost possession. Alvarado argued the provision did not apply because BofA never had the note while the bank contended that WaMu had the right and thus, it did too, as WaMu's successor in interest.

Thurber noted that there was no state court case on the issue. And she distinguished a federal bankruptcy court ruling on which Alvarado sought to rely, Kemp v. Countrywide Home Loans , No. 08-2448, decided last Nov. 16. There, Chief U.S. Bankruptcy Judge Judith Wizmur disallowed Bank of New York's proof of claim on a mortgage because it did not acquire the note until after the claim was filed.

Wizmur was also faced with whether 12A:3-309 applied and had been presented with a 2007 certification stating that the original lender, Countrywide, lost the note. But in September 2009, shortly before trial, Bank of New York claimed the note had been found and it now had possession. As a result, the issue of entitlement to enforce a lost note was not before Wizmur, wrote Thurber.

Courts have split on the lost-note issue, some holding that the loss precludes enforcement by an assignee or successor, others finding that enforcement rights can be transferred to non-possessors and still others allowing enforcement by relying on assignment as a "gap filler," wrote Thurber.

She came down on the side of allowing enforcement to avoid the inequitable result that otherwise, no entity would be able to enforce the note obligation, resulting in a windfall to Alvarado.

The law also requires that where the court finds that someone who does not possess an instrument has the right to enforce it, the defendant have adequate protection from the possibility that the one who does possess the note might come along later and try to collect on it.

Thurber found it unlikely that someone else would try to enforce the note given the passage of time — more than four years — since it was lost, the fact that it was lost almost immediately after being signed and the absence of any else demanding payment on it up until now.

Alvarado's lawyer, Adam Deutsch, of Denbeaux & Denbeaux in Westwood could not be reached for comment. Bank of America attorney, Christopher Ford, of Zucker, Goldberg & Ackerman in Mountainside, did not return a call.

Judge Finds Equity Allows Foreclosure To Proceed Though Mortgage Note LostRuling is a setback to the 'produce the note' defenseMary Pat Gallagher

New Jersey Law Journal

January 18, 2011

A Bergen County chancery judge says a foreclosure action can go forward even though the original lender lost the mortgage note and thus never passed it along when it assigned the mortgage to the bank now trying to enforce the debt.

The Jan. 11 ruling is a rare bit of good news for mortgage lenders, who are under increased judicial scrutiny and face a possible suspension of foreclosures in New Jersey over alleged "robo-signing" and other lax practices.

Superior Court Judge Mary Thurber granted summary judgment for Bank of America even though it did not possess the note, as required to enforce a mortgage under the New Jersey version of the Uniform Commercial Code.

Thurber based her decision on principles of assignment and unjust enrichment. "The common law doctrine of assignment is sufficiently broad to permit assignment of the right to enforce a lost note," she wrote in Bank of America, N.A. v. Alvarado, BER-F-47941-08.

Even if it is not, "the equitable remedy of unjust enrichment would still compel the result reached here," because "to preclude enforcement ... by plaintiff, whose predecessor paid valuable consideration to acquire that right ... would unjustly enrich defendant," she wrote. "This court will not cause that result."